Seeking a stable formula

The world’s biggest chemical firm buys into a less volatile business

WILD gyrations in the level of orders are enough to kill most businesses. In the chemical industry, they are routine. When economic crisis hit in 2008, demand for the basic chemicals used in everything from paints to plastic bags plummeted. BASF, the world's biggest chemical company, saw its profits drop by half as both volumes and prices slumped. Although prices are now improving, that usually triggers capacity-building, which soon leads to a glut. No wonder, then, that BASF is attempting to dampen the perpetual upheaval, most recently through the purchase it announced on June 23rd of Cognis, a more specialised chemicals firm.

BASF has coped with the swings of recent years better than most. Its size helps: it always has some big plants somewhere that can benefit from a few months of quiet so that maintenance workers can open them up for a good scrubbing. Diversity helps too, since the prices of some chemicals may hold up better than others. And it has become well practised in the art of ruthlessly cutting costs.

But for all these advantages, BASF also faces some real constraints. One is that as fast as it is growing in developing countries, it still has a huge presence in developed ones where employees are expensive and ageing. More important, perhaps, is that its shareholders expect good returns on their investment, whereas some competitors, especially state-backed ones in the Middle East, invest to provide jobs and economic diversification rather than profits. The result is overcapacity, which brings down the returns for all producers.

Given all this, BASF has for some time sought to reduce its dependence on commodity chemicals. Instead it wants to move into more specialised products with higher margins and steadier demand. It is not the first chemical company to head down this path. Britain's ICI, once a sprawling, integrated chemicals giant like BASF, spun off so many of its divisions that it ended up vanishing altogether as an independent company. Some of BASF's competitors have pushed into pharmaceuticals and health care.

Swallow and trim

Few, however, have been as successful as BASF, which has proved adept at swallowing smaller competitors and then cutting their costs. Last year it bought Ciba, another specialist, and, despite grumbles that it had overpaid, seems to be getting its money's worth by expanding its offering of the lucrative chemicals used to make paint and purify water.

Now BASF hopes to repeat the trick with its purchase of Cognis, a smaller firm whose products are used, among other things, in cosmetics, food additives and household cleaning products. These achieve higher margins than most commodity chemicals and enjoy fairly stable demand. Even in the depths of last year's recession Cognis was generating cash and paying down debt.

The value of the deal was €3.1 billion ($3.8 billion), of which only $700m was the purchase price with the rest made up of debt that BASF will assume. As with the Ciba takeover, there are some complaints that it is overpaying. Moody's said the takeover may affect BASF's credit rating, although it acknowledged that the firm should have no trouble raising money and was generating cash. Over the longer run it seems an attractive deal because it makes BASF the world's biggest supplier in markets that are growing fast and have big barriers to entry.

In the boom that preceded the financial crisis, chemical conglomerates like BASF risked falling prey to swift-footed private-equity firms which, armed with limitless cheap finance, would dismember them and then sell or float the various component businesses. But Cognis's private-equity owners have been trying to divest themselves of it since 2005, with their plans repeatedly undermined by stockmarket downturns. Now, with credit harder to find, the big conglomerates with their diverse sources of cash are finding that they have become the predators.